Russian equities rally more than 7%, as oil prices soar

UBS analysts are bullish on Russia, while IMF, Moody's are less sanguine

By

PolyaLesova

NEW YORK (MarketWatch) -- Equities in Russia rallied Monday, with soaring oil prices and optimism over a global economic recovery encouraging investors to flock to this year's best-performing emerging market.

In Moscow, the dollar-denominated RTS stock index surged 79 points, or 7.3%, to end at 1,167. Energy, mining and financial shares led the market higher.

At Moscow's other exchange, the ruble-denominated Micex index rallied 7.4% to finish at 1,206.

The RTS index has soared 85% for the year to date, making Russia the best-performing emerging market in the world. This is a remarkable reversal for Russia, which was the world's worst-performing emerging market last year.

Russia dramatically has outperformed the MSCI Emerging Markets Index, which is up 36% for the year.

Investor sentiment toward Russia is inextricably tied to the price of its key export: oil. The equity markets in Moscow are dominated by oil and gas stocks.

Oil futures rallied in New York to trade above $68 a barrel on Monday. Over the last three months, crude prices have soared 52%. See Futures Movers.

UBS is bullish on Russia

Two bullish reports from UBS -- one on the Russian economy and one on the stock market -- boosted sentiment as well.

In a report called "The Trough Is Behind Us," UBS economist Clemens Grafe wrote Monday that Russia will be back on a sustainable growth path by the third quarter of this year.

Russia's economy contracted by 9.5% year over year in the first quarter of 2009, but UBS said that the 9.5% contraction doesn't "accurately reflect the underlying sustainable-growth trend."

UBS expects that the Russian economy will contract by 4% for 2009 as a whole. More stable commodity prices and ruble exchange rate, moderating inflation, interest-rate cuts and low leverage in the system signal that economic growth should resume soon, according to the firm.

Based on its outlook for the Russian economy, UBS strategists also expect the rally in Russian equities to continue. In a separate report Monday, Dmitry Vinogradov of UBS said the rally "has not run out of steam."

Attractive valuations, investors' neutral positioning on Russia as well as improving global outlook for equities are all reasons for optimism that the rally will continue, the firm added.

"Following the strong rally by exporters, we now recommend starting to rotate into domestic names, which should benefit from any economic upturn and strengthening currency," Vinogradov wrote.

Reasons for caution

'Even as optimism is rising with oil, the fact remains that GDP fell by over 10% in April and the rate of decline in other macro indicators, including unemployment at over 10%, show no signs of slowing.'
Chris Weafer, Uralsib

Yet some observers are less sanguine than UBS about Russia's prospects.

The International Monetary Fund said Monday that Russia's economic outlook is "challenging." The IMF expects the nation's economy to shrink by 6.5% this year and to remain stagnant next year.

Russia is "highly vulnerable to shocks through the capital account," Poul Thomsen, head of the IMF mission to Russia, said in a statement Monday. "On the banking side, a comprehensive plan to address the bad assets and associated capital shortfalls is urgently needed."

Russia's central bank doesn't yet have a full picture of the situation in the banking system, Thomsen added.

Meanwhile, Moody's Investors Service said Monday that the current level of nonperforming loans in Russia has likely more than doubled to 11% of total loans at the start of the second quarter of this year, from 4.6% in early 2008.

An additional 10% to 15% of loans have been restructured to avoid payment default, according to Moody's. By the end of the year, the ratings agency expects that NPLs could increase to 20%.

Chris Weafer, chief strategist at Uralsib in Moscow, cautions that despite the rally in Russian equities, big problems remain in the economy.

"The rising price of oil continues to be the main driver of sentiment toward the ruble and equities in Russia," he wrote to clients. "Even as optimism is rising with oil, the fact remains that GDP fell by over 10% in April, and the rate of decline in other macro indicators, including unemployment at over 10%, show no signs of slowing.

"The debt-restructuring issue is very significant and bank nonperforming loans are still the big elephant in the economy," Weafer said.

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